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When assessing a dividend stock, I think it’s important to consider its yield, track record, and recent share price performance. And looking at all three measures, British American Tobacco (LSE:BATS) fares rather well.
Based on amounts paid over the past 12 months (237.88p), the stock’s presently (11 July) yielding 6.4%. This makes it the eighth-highest yielding share on the FTSE 100.
And thanks to its strong cash flows and earnings growth, it’s been able to increase its dividend each year for a quarter of a century.
Also, the yield for BAT, as it’s known, hasn’t been inflated by a falling share price. The group’s shares are currently changing hands for 28% more than they were five years ago, in July 2020.
So far, so good.
A period of transition
But the company’s moving away from the sale of traditional tobacco-based products towards – in its own words – “a smokeless world built on smokeless products where, ultimately, cigarettes have become a thing of the past”.
This is driven by a fear that, one day, cigarettes will be stubbed out for good. Whether this is because their sale’s banned (or restricted) in most parts of the world — or due to an increasingly health-conscious population not wanting to smoke – is largely irrelevant. Either way, the impact’s the same.
And this poses a big problem for BAT. It’s currently able to pay a generous dividend because it produces a cheap-to-make addictive product. This means it earns attractive margins and is hugely cash generative.
Not as profitable
During the year ended 31 December 2024 (FY24), the group reported a gross profit margin of 69.3% on its traditional combustibles products. By contrast, the margin for its New Products division was 55.7%.
This might not sound like a huge difference but apply the lower figure to its FY24 combustibles revenue and the group’s profit would have been £2.8bn lower. For context, its profit after tax was £3.2bn.
In this scenario, even if the group retained its current policy of returning 65% of its long-term sustainable earnings to shareholders, its dividend would be much lower.
Of course, its non-combustible products are still relatively new. As production’s scaled-up, I’m sure it will be able to achieve some further efficiencies. Even so, I doubt the group will be able to replicate the margin earned from the sale of cigarettes.
That’s assuming, of course, that governments don’t further restrict the sale of these alternative products.
Another potential issue is that product development doesn’t come cheap, which could be a problem for a group that already has plenty of debt on its balance sheet. At 31 December 2024, it disclosed borrowings of £37bn.
Final thoughts
Looking at BAT’s accounts, I suspect the demise of cigarettes is still a long way away. The group sold £20.7bn of traditional products in FY24. Its new alternatives accounted for only 13.2% of revenue.
Therefore, on balance, I think the group’s dividend is secure for a while yet. And analysts appear to agree. The consensus is for both its earnings and its payout to increase over the next three years.
However, I like to take a long-term view when deciding whether to invest or not. And in the case of BAT, there are just too many moving parts for my liking, despite the attractive dividend on offer.
